How Much Car Can You Really Afford?

Americans appear driven to combine their love for cars and debt. A new report finds that auto loans are becoming bigger than ever as car prices continue to increase across the nation. However, consumers should avoid wrecking their budgets to purchase more car than they can afford.

The path to vehicle ownership is paved with debt. According to Experian Automotive, a global information services company, the average amount financed for a new vehicle in the fourth quarter of 2013 was $27,430, up from $26,691 a year earlier. This is the first time in history the amount exceeded $27,000, and the highest average loan amount since 2008. Furthermore, the average loan amount for a used vehicle also reached a new high at $17,974, up $345 from the fourth quarter of 2012.

In order to keep monthly payments lower, more buyers are turning to leases. The average monthly payment on a new lease was $420, compared to $471 for a new loan. “Leasing continues to grow in popularity among car shoppers, especially those hoping to stay within a strict monthly budget,” said Melinda Zabritski, senior director of automotive credit for Experian Automotive. “Our analysis this quarter showed that the average monthly lease payment was $51 lower than the average loan payment, which can make a big difference to consumers trying to stretch their dollar.”

While leasing a car may sound like a good idea at first, most financial advisers agree that purchasing a car is typically the wiser move in the long run. When you lease a car, you never truly own it and will always be saddled with a monthly payment. It can also be difficult to get out of a lease if a financial emergency arises. On the other hand, when you purchase a car, you can build equity and keep the car well beyond the length of the loan, enjoying years of no monthly payments.

Since the price of a brand new light vehicle reached $32,160 in February, consumers should set some rules for themselves. There are many guidelines for how much drivers should spend on a vehicle, but one common strategy is the 20/4/10 rule. This means that people should put down at least 20 percent, finance it for no longer than four years, and not let total monthly vehicle expenses (including principal, interest, and insurance) exceed 10 percent of gross income.

Abiding by these rules may mean shopping for used cars instead of new ones, but it will help you escape the pitfalls of debt. Experian also found that 20 percent of all new auto loans in the fourth quarter were more than six years in length, which is a statistical way of saying a large amount of consumers bought more car than they can really afford. If you really want to be conservative with your car-buying habits, restrict yourself to only paying cash and keep the vehicle for at least five years.